The IRS operates the same way here, otherwise everyone would be starting up "businesses" for their various hobbies and deducting as much as possible. The Nolo book "Home Business Tax Deductions" is a great primer on all the specific steps one needs to take to ensure their business does not get classified as a hobby by the IRS.
Ultimately if you really have the genuine intent of running a business, you're going to have plenty of evidence to indicate that. But for those curious, I read/own this book and it was very helpful: http://www.nolo.com/product.cfm/ObjectID/0EB8204C-4889-4C7B-...
This is usually not a concern for most startups, but for people who might be trying to turn their passion/hobby into a money-maker this is a useful guide to ensure you don't get burnt.
As to your hypothetical, though, my curiosity is piqued:
Let's say the Household's businesses are losing $250k a year of the Household's money.
Why should they pay tax on $500k of income? Their income is $250k in your hypothetical.
If the businesses ARE losing money, then the household as a unit has less income, so why not tax the household on its actual income?
If I spend $10K on improvements to my daily driver classic Mustangs, I shouldn't be able to deduct those expenses. If I was a business engaged in restoring them for re-sale, then those expenses should be deductible.
Grandparent's point was if husband makes a ton of money at his day job, that his wife shouldn't be able to call their hobbies of sailboating or horses or their vacation house that they rent out to friends one weekend a year as "businesses" that lose money and as a result make those expenses payable with untaxed income.